A box spread is a known tool in option trading. A box spread is a combination of four distinct option positions having a common expiration date. This combination of four option positions will dictate that, at the expiration, the seller of the box spread shall return a fixed sum of money to the buyer of the box spread, regardless of what the price of the underlying asset is at that point in time. The initial price of the box is thus the net present value, at the time of the box spread trade, of the fixed sum to be repaid by the seller to the buyer of the box spread at the expiration. Typically, the initial price of the box spread is below that of the sum to be prepaid on the expiration date, tantamount to applying a positive interest rate for the determination of the net present value.
Further, with an option box spread traded based on options listed at an exchange, the positions are novated to the clearing house associated with the exchange. The trade is guaranteed by the clearing house by the process of novation, i.e. substitution of the clearing house as the counterparty of the trade for both the buyer and the seller. As such, the buyer and seller of the options box spread will no longer be exposed to the credit risk of the original counterparty. The clearing house, in turn, manages risk by requiring the market participants to transfer sufficient collateral to guarantee the performance of each counterparty. In the case of an option box spread trade, the buyer posts cash dictated by the price of the box spread, while the seller of the box spread posts sufficient collateral, typically securities with a liquid market, to guarantee the repayment amount at the expiration of the options. As such, the arrangement is tantamount to a loan from the buyer of the box spread to the seller of the box spread, with the exchange clearing house standing in the middle to serve as a custodian and manager of the collateral posted by the seller of the box spread.
Given that the option box spread is equivalent to a collateralized borrowing/lending transaction, the most relevant basis for trade negotiation would be the interest rate for the loan. With the interest rate embedded in the discounted value, the fluctuation of the interest rate becomes obscured by the passage of time, for example. It would be desirable to provide a system and method to facilitate listing, quoting and trading box spreads in the most appropriate quoting convention, as well as to provide a facility to trade the box spread on a forward basis.